Patience Pays Off for a Value Fund


David King, manager of Putnam New Value Fund (PANVX), considers attractively priced stocks as long as they have long-term potential. He doesn't mind if a bargain stock has a bad month or two while he waits for a turnaround. "We're not looking to keep the dust down," King says of his long-term focus.

The manager also likes to hold a fairly small number of stocks. New Value is a relatively concentrated portfolio of 75 stocks, with the top 20 positions making up about half of the fund.

While his focused approach and tolerance of market ups and downs may have boosted his fund's risk profile, it has also generated handsome returns. The fund's

standard deviation is slightly higher than its large-cap value peers, but investors have been paid for the extra risk since the portfolio has steadily outperformed since the late 1990s.

For the five-year period through July, New Value rose 5.6% annually on average, vs. a gain of 1.5% for its peers. More recently, the fund has also outrun its peers. For the one-year period through July, the portfolio rose 19.1%, vs. 14.9% for its peers.

Though the fund underperformed during the tech bubble in 1998 and 1999, King, who has managed the portfolio since 1995, says he wouldn't manage money differently in another hyper market. "I would sit out the euphoria," he says.

Bill Gerdes of Standard & Poor's Fund Advisor recently spoke with King about the fund's investing strategy and top holdings. Edited excerpts of their conversation follow:

Q: What are the investment goals of the fund?

A: New Value seeks total return and capital appreciation through a relatively concentrated portfolio of about 70 stocks. The top 20 holdings generally account for about half of the fund. We look at companies that have been in business for 10 years and that have trailing 12 months of revenues of at least $1 billion. We look at discounted cash flow.

Q: How does New Value differ from Putnam's other value funds?

A: We're willing to take more risk to get higher returns. Most other funds at Putnam are explicitly conservative. We're not looking to keep the dust down. I don't mind having a bad month or a bad quarter. This fund focuses on superior total return over time. Our higher risk profile comes from being more concentrated. The road to superior returns in value investing probably involves being concentrated.

Q: Like other value investors, do you look for out-of-favor companies?

A: We look at the best relative assets, based on discounted cash flow. This may result in good companies that are out-of-favor, as in 2000. At other times, we've also ended up with controversial companies, like Tyco International (TYC). But I don't look for controversy. I don't look to own all the stocks that people hate. If we think something has long-term value, we're willing to consider it.

Q: Which areas of the market currently offer the best opportunities?

A: At the moment, the market is not out of balance. Currently, opportunities are spread across sectors, including some consumer cyclical companies, which look attractive. We have good-size positions in Home Depot (HD) and Masco (MAS).

The market has backed off financials, but we like Citigroup (C), which has lagged since Sandy Weill stepped down as CEO. There haven't been any negative changes there since, but the stock has lagged.

We also like some high-quality companies that are less understood, such as Service Corp. International (SRV), a large funeral-home company, and Hercules (HPC), a specialty chemicals producer.

Q: Have you found any opportunities as a result of high oil prices?

A: Oil has probably created a short-term problem in the market cycle, but that provides an opportunity, if my view that there's an $8 to $12 premium on oil for political problems is correct. Oil prices tend to resolve themselves, but don't ask me when. The fund is overweight in transportation, basic industrial conglomerates, and aerospace and defense, all of which will benefit from lower energy prices.

Q: Why have the fund's long-term returns been competitive?

A: Value investing, which did horrendously from 1998 through early 2000, has really come back in favor following the Nasdaq [bubble] bursting. We capitalized on brief periods of panics in 2001 and 2002 by buying consumer cyclical and insurance companies, like Rite Aid (RAD), Circuit City Stores (CC), and ACE Limited (ACE).

Q: Why were the late 1990s difficult times for the fund?

A: I wasn't cheating then. Many value managers lagged in that period, but I pursued the same value philosophy through Y2K and the new economy era.

Q: Did you learn anything by going through the Internet bubble in the 1990s?

A: I'm surprised how little I learned from the bubble. I would do the same things again if the bubble happened again. I would sit out the euphoria.

Q: What are the fund's largest holdings?

A: As of July 31, they included Exxon Mobil (XOM), Tyco, Citigroup, Federal National Mortgage (FNM), and Bank of America (BAC).

Q: What stocks have you added recently?

A: I've added Boeing (BA), Lockheed Martin (LMT), and U.S. Bancorp (USB). U.S. Bancorp is one of my favorite banks, and it's performing well.

Q: What's your view of Berkshire Hathaway (BRKb), one of the fund's holdings?

A: It will be a good stock for a long run. Warren Buffett has good people running his major operations. Right now, Buffett feels it's not a good time to buy stocks.


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